Moody’s Investor Service released their annual sector outlook today for not-for-profit health care organizations, stating that they (Moody’s) continue to maintain a “negative” outlook on the industry. Important to note in this report is that the focus is principally on hospitals and since the report is produced by Moody’s, its primary perspective is on credit and investment. That said, even with the predominant focus being on hospitals, there is quite a bit of take-away information for non-profit health care providers in general, including those in the post-acute sectors.
The emphasis Moody’s places on their negative or dim outlook is economic related primarily and public policy weighted secondarily. They point to the continued weak economy as the cause for slack patient volumes and concerns regarding provider debt levels, particularly those providers that may be facing an expiring Letter of Credit (LOC) situation over the next twelve to eighteen months. With regard to public policy issues, Moody’s points to budget insufficiency issues in Medicare and Medicaid foreshadowing tighter or declining reimbursements and uncertainty of the outcome of health reform although, as they indicate, the legislation today, is effectively in limbo.
According to Moody’s, the weaknesses inherent for non-profits are their reliance on governmental sources for payment more so than proprietary operators and their need to be cautious of their tax-exempt status in terms of a political culture requiring more and more justification of expenditures made on behalf of the uninsured or under-insured population. I would also add that other forces such as unions are today, targeting non-profits more so than ever and the result is higher labor costs and higher legal defense costs (to abate organizing campaigns). Similarly, the plaintiff’s bar is far more active today and for non-profits, their fair-haired status once given due to religious affiliations primarily, is all but gone. It is not uncommon any longer for attorneys to seek damages against large or for that matter, even small to medium-sized non-profit providers.
The report cites the following reasons as the primary factors contributing to Moody’s negative outlook.
- Sluggish patient volumes due to high levels of unemployment combined with the loss of health insurance.
- Pressure on revenue streams, particularly Medicare and Medicaid combined with intensified recovery activity (RACs and Probes).
- Greater difficulty in cutting costs due to the cost-cutting measures already undertaken in 2009 and late 2008. There is little room remaining for significant expense reductions.
- Increasing bad-debt exposure.
- Debt structure and liquidity risks driven by high bank exposure, potentially expiring LOCs and less than a full recovery of investment losses.
- Greater or increasing capital needs after a year or more of deferred capital spending.
- Expiration of the federal stimulus program at year-end 2010.
In addition to the above negatives, Moody’s cites three positive factors.
- For some providers, strong management capability that allows the provider to respond quickly to negative operating changes and positive improvements as they occur.
- Partial recovery of investment losses adding back some liquidity.
- Likely increase in merger and acquisition activity which Moody’s believes is good for the market.
As I reviewed the report, my conclusions are as follows. These conclusions I believe, are universal for all non-profit health care providers.
- The pace of economic recovery will push forward or hold back, the recovery of non-profit health care provider’s fortunes. A quickening pace including job growth will help providers recover quicker although a lag in terms of patient volume increases will clearly be present. A slow, mixed recovery with equally elongated new job creation will hurt providers and potentially, lead to insolvencies and failures. The key to remaining solvent in the event of a slow recovery is debt structure, depth of product/service mix and generally low non-wage related labor costs (turnover, legal issues, compliance problems, supplemental staffing costs, etc.).
- Access to capital at reasonable terms will remain an issue for the sector throughout the bulk of 2010. While I see some softening, the present stance the Feds are taking on taxing the banking industry could very quickly, chill any warmth that has softened the credit markets. Within the next twelve to eighteen months, a very large ($19 billion) amount of Letters of Credit will come due. Providers with struggling balance sheets or under-performing newer projects may struggle to meet new conditions and terms to enhance their credit. Without question, debt costs and the related costs associated with debt issuance will continue to be higher than any period over the last five plus years. The significant question remaining about access to capital is what role the Feds will play and will they continue to bolster lending activities via HUD to help stabilize some of the credit/lending markets.
- Of particular concern to me and in concert with the point immediately above is the growth in deferred capital investing that is occurring, particularly in the SNF industry. This industry is already dominated by aging physical plants and as providers have been forced to defer capital investment due to the economy and due to the reimbursement climate, the industry continues to shed asset wealth via depreciation and become more functionally obsolete. With growing regulatory pressure for SNFs in terms of environmental standards and new mandates on fire suppression systems, access to reasonable cost capital will be imperative for this industry to modernize and recapture at least a portion of its physical plant asset wealth.
- With health reform on the Washington back-burner for the moment, I believe providers will tend to breath a collective sigh of relief – prematurely. While I believe that a reform conflagration is not imminent, the fiscal woes of Medicare and Medicaid trudge on and as a result, the reimbursement outlook from my perspective, remains rather bleak. There will be continued financial pressure at the federal and state levels to reduce or reign in the trajectory of entitlement spending and as a result, I believe providers need to be vigilant about the prospects of flat to declining reimbursement rates. Of particular concern to providers should be Medicaid which today, is heavily bolstered by federal stimulus dollars set to evaporate in December. With state budgets remaining in the “tank” due to the slow recovering economy, states are going to be looking for Medicaid savings with a vengeance unless the feds continue additional matching provisions or add new dollars.
- In the merger and acquisition area I’m less of a believer that this market will heat-up than Moody’s is. I think that the time is certainly ripe for some increase in activity but I believe that the credit markets will have more to say about the volume than the desire of providers to acquire or be acquired. I do believe however that this is an opportune time for non-profits to look at merger and affiliation arrangements as opportunities are plentiful, the benefits of consolidating balance-sheets are obvious, synergies can be maximized across and within markets, and the costs of mergers/affiliations are far less and can be completed with minimal to no need for new debt.
Any readers that would like a PDF copy of the Moody’s report can go to the Author page and send me an e-mail request. In your request, please provide me with your full name and a working e-mail address that I can use to forward the document.